Why Hess, Not Exxon, Is Rated Near 'Strong Buy'

| About: Hess Corporation (HES)

Following the recent release of disappointing U.S. GDP growth, concerns are naturally looming about end market demand for energy companies. After falling 9.8% for the 5-day trading week ending 27 January, Hess (NYSE:HES) continues to be rated a near "strong buy" while Exxon Mobil (NYSE:XOM) is rated a weak "buy". I concur with the bullish sentiment on Hess, but am considerably more reserved about Exxon.

From a multiples perspective, Hess is the cheaper of the two. It trades at a respective 9.9x and 8x past and forward earnings, while Exxon trades at a respective 10.3x and 10.4x past and forward earnings. With that said, Exxon has a dividend yield that is 150 bps higher at 2.2% and is 50% less volatile than the broader market.

At the fourth quarter earnings call, Hess' CEO, John Hess, noted several ways the company is positioning itself for more sustainable free cash flow generation:

"Over the past several years, we have significantly increased our commitment to unconventionals to generate more predictable growth in reserves and production. In 2012, we plan to invest $2.5 billion or nearly 40% of our projected spend in unconventionals. In addition, we plan to invest $1.6 billion for production, $1.8 billion for developments and $800 million for exploration.

We expect to fund the majority of our 2012 capital program from internally generated cash flow and asset sales. To protect our cash flow, we have hedged 120,000 barrels of oil per day or approximately 45% of our forecasted oil production for the calendar year 2012 at an average Brent price of $107.70 per barrel".

Oil makes up more than two-thirds of Hess' business mix. While it has gained from the pricing improvement of oil and natural gas, it also has strong diversification that hedges against "hiccups" in any one region. For example, the company is setting up new projects in Africa and Indonesia due to instability in egypt and Libya. It further is targeting a $1B annual project at its onshore oil Bakken play, which will help drive the 3% production growth target. The project will be transformed into a generator of 60K boe/d by 2015, up more than 250% from current if goals are met. Management recently closed its 350 mb/d HOVENSA refinery given weak underlying demand and a greater interest in emerging markets.

Consensus estimates for Hess' EPS forecast that it will grow by 17% to $6.68 in 2012 and then by 20.4% and 1.7% more in the following two years. Of the 17 revisions to estimates, 12 have gone down for a net change of -4.8%. Assuming a multiple of 11x and a conservative 2013 EPS of $7.74, the rough intrinsic value of the stock is $85.14, implying 54.1%. Even if the multiple plummets to 8.5x and 2013 EPS turns out to be 8.7% below consensus, the stock would still rise by 12.9%.

Exxon has struggled from a challenging business environment as poor natural gas prices have added uncertainty to XTO Energy and rendered it around 2% dilutive to EPS. With that said, the acquisition only represents one-tenth of Exxon's current production . In addition, Exxon may be more exposed to oil than what the market acknowledges due to its oil indexed LNG volumes. Large land holdings further allow for flexible development while top capital allocation and operations mitigate risk for investors.

Consensus estimates for Exxon's EPS forecast that it will grow by 35.2% to $8.41 in 2011, decline by 0.8% in 2012, and then grow by 8.3% in 2013. Assuming a multiple of 11x and a conservative 2012 EPS of $8.27, the rough intrinsic value of the stock is $90.97, implying just 6% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.